If they read their own research, economists might disclose conflicts of interest more often.

Commentary about business and finance.
Jan. 5 2011 5:22 PM

The Economics of Economists' Ethics

If they read their own research, economists might disclose conflicts of interest more often.

Reykjavík in Febuary, 2010. Click image to expand.
Reykjavík, Iceland

When the American Economic Association kicks off its annual meeting tomorrow in Denver, the normally staid convention will be tinged with controversy: On the agenda is whether economists should adopt a code of ethical standards. The proposal comes after the housing crisis, the credit crunch, the financial crisis, the recession, the collapse of several European economies, and the overhaul of U.S. banking regulation dealt their respective blows to the prestige of the profession. More to the point, it comes after a long series of notable economists offered opinions or wrote papers pertaining to those events without disclosing major conflicts of interest.

Charles Ferguson, in his documentary Inside Job, tells the tale. Former Federal Reserve Board member Frederic Mishkin, for instance, took $124,000 from the Icelandic Chamber of Commerce "to write a paper praising its regulatory and banking systems, two years before the Icelandic banks' Ponzi scheme collapsed." Others have taken aim at White House economist Larry Summers (who earned millions with hedge fund D.E. Shaw) and his probable replacement Gene Sperling (who earned nearly $1 million from Goldman Sachs in 2008). The longer the résumé, the more prominent the economist, the more likely the opportunity for conflicts.

Now, economists are lining up on either side of the debate. Some argue that the AEA—not a licensing organization—does not have the stature to dictate ethical codes. * Conversely, 300 economists yesterday issued a public letter arguing that economics should have done so a long time ago. "As the economics profession serves a prominent role in economic policy, the public's confidence in the integrity of the profession will, in part, depend on how the issue of potential conflicts of interest is addressed," the letter says.

So economists have plenty to say about ethics. But what does economics have to say about economists and ethics? As it turns out, there is plenty of academic literature on the subject. And according to the research, economists better get ready to add a few lines to their résumés.

There is research, for example, demonstrating economists' occasional lack of what we might call consideration for their fellow man. (Put less gently: The literature describes a profession of amoral Scrooges.) In one paper, for instance, researchers set up simple zero-sum games between students of various disciplines, including economics: One player decides how to divvy up a $10 pool of cash; the other accepts or rejects his portion. When economists did the divvying, they proposed keeping $6.15, on average. Noneconomists proposed keeping $5.44. The verdict? Economists tend to be "self-interested." Another study found that economics professors give less than half what other professors give to charity, even though they make more. Another confirms the bias outside the classroom, describing how economics students are more likely to "free-ride in experiments that called for private contributions to public goods" than other students. In English: They put their own profit first, even when the game calls for the maximization of public value.

So some economists are weasels. Big deal. So are a lot of journalists. Shouldn't they be judged on the quality of their work? Yet there, too, the research shows some cause for concern. The Political Economy Research Institute at the University of Massachusetts looked at economists advising on the Dodd-Frank bill, which overhauled the federal government's financial regulation framework. The researchers studied the prominent economists behind the Squam Lake Report, a comprehensive series of suggestions for regulatory reform. They found that the economists fully reported their affiliations in their academic work just 2.3 percent of the time. They gave the full extent of their affiliations in media appearances just 28 percent of the time. The best-performing economist disclosed fully only 71 percent of the time.

Reuters performed a similar review last month, this time looking at economists' disclosures when testifying before the Senate banking committee and House financial services committee. The news organization examined 96 testimonies by 82 academics. In about one-third of testimonies—which are given under oath—the economists failed to disclose when they were being paid for consulting for companies that would be regulated under Dodd-Frank.

Such failures to disclose surely seem problematic. But do they really have a real-world impact that might hurt shareholders or public citizens? There, the economics literature seems to imply yes, if indirectly and not definitively: Conflicts of interest regularly distort a variety of outcomes in a variety of disciplines, from medicine to law to sports to finance. (I could not find any studies about economists specifically.)

Consider the conflicts of interest that confront, say, banking analysts, who comment on the financial health and prospects of public companies in research reports. A large body of research shows the influence of bias in earnings forecasts. Translation: If an analyst works in the research division of a big bank, and the big bank's investment arm has a relationship with a company under the analyst's purview, the analyst tends to put a "buy" recommendation on it more often.

But can disclosure laws actually change outcomes? The answer, again, is yes, at least in a number of other realms. One study, for instance, looked at a change to the Securities and Exchange Commission's rules, requiring every public company to publish its managers' discussions of whether current earnings would mean future earnings. The result? More accurate share prices.

More to the point at hand, the theory holds when the public pressures (or the law requires) politicians to disclose their financial conflicts of interest. A study by, among others, Harvard's Andrei Shleifer—once embroiled in a big ethics scandal of his own—collected data on political rules for conflict-of-interest disclosure in 175 countries. "Although two thirds of the countries have some disclosure laws, less than a third make disclosures available to the public. Disclosure is more extensive in richer and more democratic countries. Disclosure is correlated with lower perceived corruption when it is public, when it identifies sources of income and conflicts of interest, and when a country is a democracy."

And it is that public trust that economists are really seeking to restore. Frederic Mishkin, for one, the economist filleted in Inside Job for his work on Iceland, has thrown his support behind the new ethics codes. He told the New York Times this week, "I strongly support having the A.E.A. clarify standards for disclosure, because increased transparency would benefit the public and the economics profession."

Correction, Jan. 6, 2011: The article originally cited the American Medical Association as a licensing organization. Return to the corrected sentence.

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